Sam Zell Pulls No Punches with ULI Crowd

Love him or hate him, the irrepressible Sam Zell makes for great theater, particularly when he's talking shop with real estate professor Peter Linneman of the University of Pennsylvania's Wharton School of Business. The two appeared on stage at the Hynes Convention Center in Boston on April 14 during the Urban Land Institute's 2010 real estate summit.

Zell pulled no punches in his analysis of the commercial real estate investment market, or his criticism of the Obama administration. But then again, the chairman of Chicago-based Equity Group Investments LLC can afford to speak his mind. In 2009, Forbes Magazine ranked Zell 77th on its annual list of the 400 wealthiest Americans. Zell's estimated net worth was $3.8 billion, tying him with leveraged buyout titan Henry Kravis and real estate and banking mogul Paul Milstein and family.

There will be no flood of distressed assets coming to market in the U.S., Zell assured conference attendees. “I'm supposedly the grave dancer, so everybody comes and talks to me and says, ‘Well, when are the opportunities going to come up?’ I answer them by saying that you don't have opportunities unless there is volume, and there is no volume.

“The only real opportunities that I think exist in the real estate business today are in two areas: one is hotels, which need to be marked to market every night. Even there the recovery in the hotel business is changing the opportunity very rapidly,” Zell emphasized. “The other opportunity, which is a very hard opportunity, is all this crap that's in all the little banks all over the country.” Those troubled assets will be priced and sold off in a manner similar to the role the Resolution Trust Corp. played in the early 1990s, according to Zell.

What Zell is doing in the distressed real estate arena on the debt side is significant. He announced that he recently bought nine hotel mortgages at a steep discount, 42.5 cents on the dollar. “That was a very difficult deal. It will require us to invest both a lot of time and money.” Taking on the hairy projects that make economic sense has become a Zell specialty.

Private equity meltdown

The Great Recession has exposed some poor decision-making in real estate investing on a grand scale. The Wall Street Journal reported last month that Morgan Stanley told investors in its $8.8 billion real estate fund, Msref VI International, that the fund could lose two-thirds of its value. That would be a $5.4 billion loss. Can we expect more private-equity funds to make similar announcements?

“I think Msref probably was significantly more aggressive than most of the funds,” said Zell. “Msref got very involved in creating real estate in a lot of different places of the world. That changes the risk-reward ratio. The fund got too big and lost control of its ability to make investments. The last time I checked, investments made by committee had a pretty rotten track record. Investments are made by entrepreneurs.”

Zell's sharpest barbs were reserved for the Obama administration. For the first time in his more than 40-year career, Zell says that he must consider a new risk when investing domestically — a political risk. “Up until this administration, you could invest in the United States. You knew the rules, you knew the rules were going to be followed, and you had a very stable environment.”

While Zell didn't expound on what he meant by that exactly, reading between the lines I think he is deeply concerned about the expanded role of the federal government and the potential for finance reform to be so overreaching that it will adversely affect the flow of capital.

Zell argued that America used to be an “aspirational society, a society where everybody wanted to do better. And we had a government, whether it was Democratic or Republican, that encouraged innovation, that encouraged risk taking. And now we have the reverse.”

The current administration's policies have slowed the economic recovery, not fed it, according to Linneman, who expressed buyer's remorse for having voted for Barack Obama and George W. Bush in the presidential elections.